Familiar Flavor To Financial Reform Bill

More than a year after the U.S. government began bailing out the nation's biggest financial firms, a key congressional committee has unveiled a bill to prevent companies from becoming too big to fail.

The draft of the bill, released by the House Financial Services Committee on Tuesday, is designed to minimize the threats from firms that are so big or interconnected that they pose a "systemic risk" to the overall economy. It also sets forth a plan to wind down troubled non-financial firms, blunting the impact that the failure of those companies can have on the economy.

As proposed, at the pinnacle of the new system would be a panel of top regulators dubbed the Financial Services Oversight Council. The membership would be a who's who of Washington's regulators (take a deep breath before reading the list out loud): The Treasury secretary, the chairman of the Federal Reserve and the head of the Securities and Exchange Commission, as well as the heads of the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Federal Housing Finance Agency and the National Credit Union Administration.

Only one regulator, the Office of Thrift Supervision, is getting the ax in this proposal.

The Treasury Secretary would chair the council. One state insurance regulator and one state bank regulator will also get non-voting seats.

The council's task will be "to monitor the financial services marketplace to identify potential threats to the stability of the United States financial system"--in other words, to watch out for financial crises and stop them before they begin. A key part of this task is identifying firms that "could pose a threat to financial stability," firms that are considered "too big to fail."

The council will identify these firms and ask their respective regulators to tighten oversight. This tighter oversight would mostly mean requiring banks to keep more liquid capital on hand. It could also take the form of limiting how much exposure a bank has to another institution, or requiring an institution to change its risk management practices.

In an apparent attempt to avoid moral hazard, no public list will be kept of these too big to fail companies. The authority is somewhat toothless as regulators are allowed to ignore the council as long as they provide a written justification for doing so. The council will also have binding authority to resolve turf battles between different regulators.

The council of regulators is remarkably similar to an advisory council that already exists: the President's Working Group on Financial Markets, which includes the Treasury secretary, Fed chair, and the heads of the SEC and CFTC.

Putting all these regulators in a room didn't provide much early warning about the crisis in 2008. In the 1990s, Brooksley Born, then the chair of the CFTC, sounded an alarm about the unregulated derivatives market, but the other regulators in the working group disagreed with her and so her efforts went nowhere--the sort of mistake a new council could easily repeat.

One of the key dilemmas the bill aims to solve is how to unwind troubled non-financial firms that pose a threat to the economy. Traditional bankruptcy procedures can be drawn out, which could endanger the overall financial system. In addition, banking regulators don't have the legal authority to "resolve" a non-financial firm.

Under the proposal put forth by House Democrats, the FDIC would take over a failing firm so that taxpayers won't have to foot the bill for a bailout, as has happened with insurance giant
American International Group
during the past year.

A troubled firm's shareholders and creditors would be responsible for bearing the costs of its resolution, but the government would also establish a Systemic Resolution Fund within the Treasury Department to help cover any additional costs. Financial firms with assets of $10 billion or more would be required to kick in money to help cover the cost of a firm's unwinding.

One concern is that the bill does little to streamline the nation's fractured system of financial regulation. And it's not clear how a council of regulators will prevent a few firms from posing a threat to the system.

These questions will be addressed in depth by the committee in the days ahead. Many questions will likely be answered Thursday, when Treasury Secretary Timothy Geithner is scheduled to testify before the panel.

But the key hurdle for Democrats won't be in getting the bill to the House floor in the coming weeks. (The party has an overwhelming majority in the House.) It'll be minimizing the influence of lobbyists and getting the Senate to produce similar legislation.